What is the deal with cancellation income?
This was based on last year's Budget announcement that VAT would be due on deposits and pre-payments for "unfulfilled supplies". What this means in practice for the general VAT rules is that, where a supply is cancelled, any monies retailed for that supply will now be subject to VAT at the rate at which the original supply would have been, at the time the deposit is paid. (So, for example, let's say that a hotel is booked and a deposit of £60 is received by the hotel on 1 September. The hotel is later cancelled and the £60 deposit is retained by the hotel. The £60 is no longer outside the scope of VAT as per the 1 March changes. Because the supply of the hotel would be taxed at 20% if it had gone ahead, the hotel is liable for output VAT at 20%.. On a gross amount of £60, this gives output VAT payable of £10 to be accounted in the hotel's VAT return which covered 1 September).
We do not agree with this approach in general, because one of the fundamental principles of VAT is that a supply must be made in order for a consideration to be within the scope of VAT. We are aware of general challenges being made to this principle, but in the meantime today's update applies for TOMS sales only.
The reason that HMRC have confirmed that cancellation income for TOMS supplies will remain outside the scope of VAT is due to the VAT "time of supply" rules.
The general "time of supply" for VAT purposes is the earlier of the date of payment, the date a service is performed, and the date of invoice. For most prepaid services, this means that the time of supply will occur on or before the date a payment is made. For TOMS services, this is not the case for businesses which use Method 1 (standard method), because the time of supply is always the departure date, and this will never occur.
If you are using TOMS Method 2 (accounting for VAT when a customer pays more than 20% of the price of the supply) cancellation charges are within the scope of VAT. it is perhaps worth mentioning though that I have never comes across a business which uses Method 2 and, if you do, you may wish to rethink this in light of this news and general cash flow purposes.